Cycling back to cyclicals

The move out of defensives into cyclical stocks is gathering pace, with several fund managers suggesting housing, retail and building materials are on the cusp of a pick-up.

Investor concern over Europe’s debt woes and the pace of recovery in China and the US has seen yield stocks chased hard, manifesting in a strong run for bank stocks (a 16.5 per cent jump since June) consumer staples (13.5 per cent) and telcos (16.3 per cent). Yet as the global backdrop improves – US budget concerns excepted – investor risk appetite has picked up, along with willingness to bet on cyclicals.

Since October,
Rio Tinto
has gained 15.4 per cent,
Boral
12 per cent and
Myer
20.2 per cent.

While some yield stocks have shown weakness in the past month, few fund managers suggest there will be a wholesale shift into cyclicals, given ongoing expected rate cuts will further widen the return of equities above fixed income.

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“We are finding some investors who were previously in banks and more defensive stocks are starting to move into cyclical stocks as China restocks and growth recovers in our largest trading partner," she said.

“But some will stay in defensive because they need yield, especially those in the pension phase as the cash rate moves lower."

For clients with a higher risk appetite, she suggests discretionary retailers, noting some may present strong value if the economy picks up.

“Our expectation is that the economy will improve in 2013 and the sharemarket always looks a few months ahead," he said.

“We don’t expect short-term economic data to look good but in the second half of next calendar year, it should improve." Mr Stott favours stocks exposed to any pick-up in the economy such as housing sector companies
Fletcher Building
,
CSR
,
Brickworks
and
Boral
. He changed some portfolio positioning in response to interest rate cuts, which he also expects to benefit financials and retail stocks.

Among retailers, Mr Stott favours Myer over
David Jones
on valuation grounds, and views
Fantastic
Holdings as the stock most sensitive to rate cuts (if discretionary spending subsequently picks up).

The chief investment officer prefers listed fund managers such as
Magellan Financial
over bank stocks – which he views as expensive – suggesting the leverage of fund managers to an improving sharemarket should see them benefit if the run continues, given their fixed cost bases.

“We are getting to the level where further rate cuts are likely to lead to further spending domestically," he said.

He concedes that some defensive sector valuations look stretched, such as listed investment trusts and utilities. “But Telstra is still not expensive and we are likely to see pick-up in housing activity."

Mr Fenton prefers stocks exposed to the US and China over the domestic economy. “Households are highly geared and while there are some improvements in the economy, there are still quite a few risks and it doesn’t look like the RBA has done enough," he said.